As the snow came down here in Baltimore yesterday, I spent the afternoon in the hotel remembering all the reasons I moved to Florida and running screens in search of safe and cheap stocks worth considering right now. None of the screens is turning up many stocks, and that becomes truer when you exclude energy-related names. When you start adding safety factors, the energy names quickly begin to disappear as well.
One of the screens I ran is my double cheap screen. While I define value using price to book, with many others I like to use Enterprise Value to EBITDA as a way to find cheap stocks. I think that's a valid and valuable measure, as it is the favored ratio of many private equity and LBO buyers.
Rather than get into a debate about which is best, I find it useful to combine the two and look for stocks that are double cheap. While the snow was flying yesterday afternoon, I ran the screen and found 75 U.S. stocks that are double cheap falling into the bottom 10% of stocks based on both measures.
The list is dominated by energy stocks, and something very interesting happens when you add a simple test of financial strength like an Altman Z-score to the screen. The list falls to just 16 stocks and almost all of the energy stocks disappear when you require a Z-score in the safe zone.
If you use a less-stringent measure and just look for those with reasonable low debt loads and high current ratios, then 18 stocks make the grade, and again energy companies are now in the minority. Many of them are indeed cheap, but it is harder to make the case that most of them are safe with an adequate margin of safety.
The same thing happens when I run a very simple screen that I have used to find safe and cheap stocks for years. Usually when I combine the work of Edward Altman and Joseph Piotroski and look for stocks with Z-scores in the safe zone and F-scores in the buy range, I get a list of 30 stocks or more. In a steep selloff, I might get 100 or more stocks that are safe and cheap with improving prospects.
When I ran it yesterday, I found just nine stocks that make the grade right now. Five of them are under $50 million in market cap and the other four are stocks that we have discussed many times, with Alpha & Omega Semiconductor (AOSL), Richardson Electronics (RELL), Asta Funding (ASFI) and Gulf Island Fabrication (GIFI) passing the screen with flying colors.
The perfect stock screen has always been one of my strictest and best-performing screens. In a normal market, there are usually around 20 stocks to pick from, and in bad markets that might get as high as 50 or so. The screen is simple but hard to pass. To make it into the portfolio, a company has to be profitable, pay a dividend and have a strong balance sheet with low debt levels and a high current ratio. Of course, the stock has to trade below book value. Right now just eight stocks pass the test, including old favorites like Gulf Island and Hecla Mines (HL). It is worth noting that this is the lowest number of qualifying stocks since 2007.
The more screens I ran, the more obvious it became to me that the continued market advance has pretty much eliminated the available pool of safe and cheap stocks. No new ones have appeared in some time now. Energy stocks have become cheap almost across the board, but very few of them also make the grade when you run simple tests of financial strength. The debt levels in the energy sector are somewhat shocking, and it looks to me like there could be some pretty widespread carnage if oil prices stay low for an extended period of time.
I am not a market timer. I don't even play one on television. However, if you are bringing new money to the market right now, it is going to be almost impossible to get fully invested in nonfinancial stocks that are safe and cheap. To play my broken record one more time, the only place I see a lot of value is in small banks, as that screen is still returning dozens of safe and cheap community banks. The rest of the market looks pretty picked over at this point in time.
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